Measures of economic performance

1. Economic Growth

  • Definition: Economic growth represents an increase in the capacity of an economy to produce goods and services, compared from one period of time to another. It is typically measured as the percentage rate of increase in real Gross Domestic Product (GDP).

  • Actual vs. Potential Growth:

    • Actual Growth: An increase in real GDP; it is represented by a movement from a point inside the Production Possibility Frontier (PPF) to a point closer to the boundary.

    • Potential Growth: An increase in the productive capacity of the economy; it is illustrated by an outward shift of the PPF or a shift in the Long-Run Aggregate Supply (LRAS) curve.

  • Measurement:

    • Real GDP: Calculated by adjusting nominal GDP for inflation using a GDP deflator: \text{Real GDP} = \frac{\text{Nominal GDP}}{\text{GDP Deflator}} \times 100.

    • GDP per Capita: Measured as \frac{\text{Total GDP}}{\text{Total Population}}, serving as a proxy for the average standard of living.

2. National Income Measures

  • Gross National Income (GNI): Consists of GDP plus net receipts of primary income (compensation of employees and property income) from abroad. It reflects the income of all citizens of a country regardless of where the production takes place.

  • Gross National Product (GNP): Total market value of all final goods and services produced by the factors of production owned by a country's residents, regardless of where they are located. GNP = GDP + \text{Net property income from abroad}.

  • Comparison: While GDP measures production within geographic borders, GNI and GNP focus on the income accruing to the residents.

3. Comparisons and Purchasing Power Parity (PPP)

  • Standardization: To compare different economies, data must be adjusted to a common currency (usually USD) and converted into real, per-capita terms.

  • Purchasing Power Parity (PPP): An exchange rate that equalizes the purchasing power of different currencies by eliminating the differences in price levels between countries. It allows for a more accurate comparison of living standards because it considers the local cost of living and inflation rates (e.g., the Big Mac Index).

4. Limitations of GDP as a Measure of Well-being

  • The Hidden Economy: Unrecorded transactions (informal/shadow economy) avoid taxation and regulation, leading to an underestimation of total output.

  • Non-Marketed Output: Services like DIY, childcare provided by parents, and subsistence farming are not traded in markets and thus excluded.

  • Externalities: GDP ignores negative environmental externalities (pollution, resource depletion). Some advocate for "Green GDP," which subtracts environmental costs: \text{Green GDP} = GDP - \text{Environmental Costs}.

  • Income Distribution: GDP per capita does not reflect how income is distributed across the population. A high average can mask significant inequality (often measured by the Gini Coefficient).

  • Quality of Life: It fails to account for leisure time, health outcomes, education quality, and general happiness/subjective well-being.

5. Measures of Inflation

  • Definition: A sustained increase in the general price level of an economy over a period of time.

  • Indices:

    • Consumer Price Index (CPI): Measures the weighted average price of a 'basket' of goods and services consumed by a typical household. It excludes housing costs like mortgage payments.

    • Retail Price Index (RPI): An older measure that includes housing costs; usually higher than CPI.

  • Causes:

    • Demand-pull: Excess $AD$ over $AS$ (too much money chasing too few goods).

    • Cost-push: Increasing production costs (e.g., wages, raw materials) shifting $AS$ to the left.

    • Growth of Money Supply: Excessive printing of money leading to a devaluation of currency.

6. Employment and Unemployment

  • Labor Force: The sum of the employed and the unemployed. The participation rate is the percentage of the working-age population in the labor force.

  • Measures:

    • Claimant Count: Number of people claiming unemployment-related benefits (e.g., Jobseeker's Allowance).

    • International Labour Organisation (ILO) / Labor Force Survey: Measured via surveys; includes those without a job who have been actively seeking work in the past 4 weeks and are available to start in 2 weeks.

  • Types of Unemployment:

    • Structural: Caused by a mismatch between the skills workers offer and the skills demanded (common in declining industries).

    • Frictional: Short-term unemployment occurring when people are between jobs.

    • Cyclical (Demand-Deficient): Caused by a lack of aggregate demand in the economy, often during a recession.

    • Seasonal: Regular fluctuations based on the time of year (e.g., tourism, agriculture).

7. Impacts of Unemployment

  • Economic Impacts: Loss of output (GDP below potential), loss of tax revenue (Income Tax, VAT), and increased government spending on welfare benefits.

  • Social Impacts: Increased crime rates, health issues, and social exclusion.

  • Hysteresis: The theory that short-term unemployment can lead to long-term unemployment as workers lose skills and motivation, reducing the economy's LRAS.

8. The Balance of Payments (BoP)

  • Structure: Records all economic transactions between a country and the rest of the world. It must balance to zero in total.

  • The Current Account:

    • Trade in Goods: Visible balance (exports minus imports).

    • Trade in Services: Invisible balance (e.g., banking, tourism).

    • Primary Income: Net flows of investment income (dividends, interest).

    • Secondary Income: Current transfers (e.g., foreign aid, remittances).

  • Deficits and Surpluses: A persistent current account deficit may indicate a lack of competitiveness or an over-reliance on debt to finance consumption.